‘Equity first’ for funding SMEs

Patrick Muchemwa (far right) shows Small and Medium Enterprises and Co-operative Development Minister Cde Sithembiso Nyoni (far left) and Minister of State for Harare Province Cde Mirriam Chikukwa (centre) some of the shoes manufactured at the BEST Co-operative complex

Dr Sanderson Abel
Financing enterprises is not an easy thing more so for small businesses who at times are not formal. For any funder to be able to release resources to an enterprise he/she needs to acquaint him/herself with a lot of information pertaining to the enterprise.

Most people kill their business ideas by making simple but lethal mistakes in mobilising the wrong kind of money. For example, debt is good for a business, but it may be best to take on debt when a business has run successfully for a while.

It is not only dangerous to start a new business entirely financed through borrowed funds. If the business idea fails, you will fail to repay the loan and possibly damage your financial reputation.

In this piece, I discuss the concept of “equity first” for funding SMEs. Before rushing of to your bank to ask for a loan to fund your start-up business or even to expand your existing operations, think about these innovative equity based financing ideas that will prepare you and your SME for a successful relationship with your bank.

Internal business finance

No matter how big your business idea is, start small and reinvest profits into future growth.

Business is all about taking risks, but you do not want to take a big risk upfront all at once. This is especially true in this environment where liquidity is tight and it is not easy to raise all the money you need to fund your big idea.

Starting small eliminates the risk of making a big mistake and also ensures that you learn the ropes of the business and thus grow in ability and confidence.

It also means that you will need smaller amount of initial capital to start the business. Your small pot of personal savings may therefore be sufficient to fund your start-up enterprise and as you trade, you must reinvest the proceeds and profits into the business.

This will naturally enhance the growth potential of your business. This is called funding the business from “internal resources”, meaning that cash-flows from the business together with your personal savings will fund the initial growth phase of the business until such a time it has gathered credibility to attract outside investors.

Use personal savings

Successful business people usually have taken huge personal financial risk at the onset. Apart from generating the entrepreneurial ideas that have made them millionaires or even billionaires, they sacrificed a huge chunk of personal savings as initial capital investment into their businesses.

Using personal savings means that you exercise total creativity in getting your business off the ground.

You have the flexibility to drive your business in the direction that you want and implement your ideas to the maximum without being accountable to other investors or a bank. It also lays a strong basis for other investors and lenders to trust you with their money when eventually your business reaches a stage when it needs an external injection of capital.

Leverage trade credit

Rather than rushing off to get a bank loan to fund short term needs of your business, make maximum use of trade credit if it is available. Negotiate with some of your suppliers for delayed payment terms rather than paying for your inputs or raw materials in cash up front.

A good start is to pay part cash and then get the difference of your input supplies on credit terms. When you are lucky to get terms, try by all means to build your business’ credit standing by settling according to agreed terms. Your credibility and goodwill as a business can become a vital asset in future.

Certain types of businesses such as furniture manufacturing or shop fitting allow for the customers to pay a small deposit towards the work being done. When you get the deposit apply it to raw materials and help ease off pressure on the funding needs of your business.

Do not take the customer’s deposit and buy a piece of capital equipment or something else that has nothing to do with their order. This is a sure recipe for disaster. If you deliver the correct quality work, your customers will be happy to pay up the balance, making your cash-flow management easier.

Talk to family and friends for funding

Your family and friends should be the first port of call not only in developing your business idea but in becoming your first customers and more importantly the first financiers of your business. Your business model is also relatively secure with friends and family and they are less likely to hijack or steal your business idea.

This group of people is therefore a good source of patient capital. You may include those who are willing partners as equity partners by giving them some shareholding. Capital from friends and family can come in the form of gifts or interest free loans. If you are a member of a savings club, most of whom may be part of your friends and family network; it will not be unreasonable to ask for a soft loan as long as you are committed to repaying it when it falls due.

Seek Angel finance

Some rich individuals are able and keen to assist a good idea from a credible honest committed individual off the ground as “angel investors”. Angel investors are often retired entrepreneurs or executives, who may be interested in angel investing for reasons that go beyond pure monetary return.

They may simply want to keep abreast of current developments in a particular business arena or may be motivated by mentoring future generations of entrepreneurs, and making use of their experience and networks. In addition to providing capital, angel investors can also provide valuable management advice, important business contacts and a useful mentoring role for the business owner.

Angel investors will normally take up equity in the business but with a clear exit plan. Because they invest relatively small amounts into the business during its initial high growth phase they get very high returns.

Lastly, bank loans

When a business has gone through these major phases of capital raising and has developed a reasonable trading record, it is finally ready to approach a bank for funding. Make sure your business plan is as clear in your mind as it is on paper, you have been maintaining sufficient trading and bank records.

Demonstrated commitment by the major shareholders or promoters of the SME by risking own resources, a good operating track record, a viable business proposition with clear future prospects will make your SME a good candidate for a successful bank loan application.

Dr Sanderson Abel is a researcher and economist. He writes in his personal capacity. For your valuable feedback and comments related to this article, he can be contacted on abelsza.mwale@gmail.com or on 0772463008.